Off The Record
Confessions of a Corporate Forex Trader
Antagonism between corporates and dealers makes the forex
world go round
The author is among the new breed of corporate forex traders who sprang
up in the 1980s when multinationals, aware of their increased need to hedge,
began raiding talent in the dealer community. He started at a small European
bank, subsequently covered some of the world's largest multinationals as
a forex salesman for a U.S. money center bank, and then crossed over to
the corporate environment in 1986. He traded forex at a Fortune 100 corporation
well-known for its financial acumen, and then at a European conglomerate.
Now back on the Street investing firm capital in hedge funds, he spoke off
the record to freely express his views of big shifts over the past decade
in client-dealer relationships in forex.
A lot of people like me left banks to work for corporations and hedge
funds in the 1980s. Because of this movement of talent, forex end-users
became smarter and more efficient. When I traded forex for a corporate,
I was determined to reduce transaction costs and tighten spreads. I'd come
into the market not telling dealers whether I wanted to buy or sell. The
dealers were not accustomed to this-and they didn't like it!
Previously, corporate treasuries were run by-or reported to-defensive
accountants who went by the book. The culture is different now. Treasury,
which usually reports directly to the chief financial officer, is more aggressive,
more willing to use off-balance sheet products, and that's all for the good,
except when they're misused-which they often are.
Banks are always trying to sell you products you can't mark to market
yourself so they can build a spread into it. At the two big corporations
I worked for, our approach was never to buy anything we couldn't price ourselves.
We bought our own software and trained ourselves to understand it. Then
we could compare our prices with the banks'. We also had a broker box so
we could see the bid/offer spread and activity in the markets. Most corporate
treasuries just get a Reuters screen, which doesn't offer the same insight.
Some dealers assumed that if they did the spot deal for us, we would
be lazy and automatically give them the forward that would reverse the trade.
We didn't. We shopped for the best forward price.
Sometimes when the market was difficult, we would give orders to two
dealers and get two different prices. That way we judged the quality of
execution-and checked if they were unloading proprietary positions before
us. The dealers respected us for our smarts, but if they could nail us,
they did. It's part of the game. We would nail them back.
Here's now we nailed them: We'd ask for a two-way quote after 3:30 p.m.
in New York, when the broker dealers weren't trading. We knew they would
have to give us a quote, since we were a big customer. Our order would move
the illiquid market. Then we would take them out on the other side. The
banks would scream! But after that kind of experience, they would be more
careful with us.
It took some dealers a little time to learn respect for us. For example,
two years ago a junior option guy tried to screw me. I was tied up with
something else and didn't have time to calculate the price for myself, so
I just said, 'Do the trade.' When I calculated it later, I saw it was way
overpriced, and asked him about it. He hemmed and hawed-so I went to his
boss's boss in London, whom I had known for years. I ended up getting the
market price, and that guy knew not to phone me again. But it was stupid
of me not to price the deal myself first, I admit.
We watched the dealers like hawks-particularly after banks began seating
their proprietary traders near their best corporate coverage guys, starting
around 1990. We worried that the bank's proprietary traders-not its market
makers-would see our orders and trade on them. It was very good for the
bank, but as a customer, I had to wonder how information from us would be
used. Would they treat me as a customer or front-run my trade? Front-running
is illegal in equities, but in forex, anything goes.
The key is trustworthy counterparties. An end-user doesn't see the same
information the big dealers see, so you need their help to understand the
market. You want the bank to give you a good price, tell you there's something
big going on in the market, and provide you with a good options strategy
at a fair price.
Naturally, the deal has to be worthwhile for the dealer. If you can trust
your dealer, you can let him work a big order. He'd rather get the full
order instead of a little piece, and know that ten competitors aren't moving
the market against him. If a dealer executed a trade well and didn't move
the market, I'd sometimes give him a pip as a fee on top of his bid/ask
spread. You're not supposed to do that, but why not? He earned it.
The kind of service worth such a fee is pretty rare. Greed is more common.
Sometimes the large New York investment banks would get a big order from
a corporation and decide not to lay it off on other dealers: If they packaged
it for other clients they could make a spread on both sides. Some very bizarrely
structured trades resulted from this.
I once took a call from an investment bank pushing a structured Canadian
note tied to the Canadian/US exchange rate. I couldn't understand why the
bank was so excited about this structure. I didn't need it, I hadn't asked
for it. The truth was, no one needed it. The bank just needed to sell it.
That's why a lot of corporations lost money in derivatives: They bought
things they didn't need.
Today's markets are more difficult than those ten years ago. There's
more event risk. I vividly remember the ERM break-up in 1993. I was on a
golf course in New York late one Sunday afternoon, when I got an urgent
call from the office. As the market was opening in New Zealand, it looked
like the ERM's fixed bands were going to fall apart. We were trading against
the bands, so our positions were starting to make big money. Our bet against
the pound ended up doing great, because Britain devalued to save its economy.
But we had a larger bet on the French franc versus the Deutschemark, which
ended up losing money because we misread the political resolve of the French
authorities to freeze the band and raise interest rates no matter what it
did to their economy. The only country in Europe doing well economically
now is the U.K., because they didn't decide to choke their economy in pursuit
of monetary union.
Of course, that summer, when Soros broke the pound, people also realized
that the hedge funds use leverage and are not afraid to have $5 billion
positions. Those guys were slamming the market left and right. They brought
huge volatility and liquidity.
Derivatives, too, are making the market trickier. When yen/dollar was
at 85 this spring, people thought they couldn't make money on direction,
so they sold volatility. Many sold options with strikes at 100. But then
the Japanese adopted a stimulative fiscal package cutting short-term rates,
and the G-7 started to intervene. Yen/dollar moved back toward 100 in the
fall, and the spot moved as much as five percent in a day. That's huge!
The moves came so fast because everyone had to delta hedge their short options
positions. If you don't have the right position on, you can't react fast
enough in a five percent daily move. Lots of people lost both on direction
and on gamma. Some had sold volatility at 12, and had to buy it back at
I was happy not to be in the market in late 1994 and 1995. To be sure,
many banks made money on forex this year, but others gave back their gains
when the yen/dollar moves failed to continue. This year was especially tricky,
because you had to be opportunistic. When there was a move, you had to take
your profits before they evaporated.
In some ways things are easier. Cash management and short term forex
trading is being automated. But there's a lot more to corporate forex management
than mere trading: Corporate treasuries have to understand their exposures
and devise appropriate strategies. It's difficult to understand the business
flows that create exposures. One major dealer told me recently that he puts
his brightest people on the corporate coverage desks, where they can help
treasurers put together hedging and refunding strategies. But understanding
those business flows is treasury's job. When I read in the press about a
CEO blaming company losses on a move in the dollar, I get angry. The treasury
department should have known about the exposure. Treasury's job is to protect
the company's profits.